Possible Income Misstatement on Mortgage Loan Applications: Evidence from the Canadian Housing Market

We construct a measure of possible income misstatement (PIM) for first-time homebuyers by quantifying the gap between growth in incomes reported on mortgage applications and growth in incomes reported on tax files from 2004 to 2014 in Canada. Using a two-stage least square framework to correct for the endogenous nature of house prices and PIM, we find robust evidence that part of the observed dispersion in PIM is caused by house price variation. This suggests borrowers have greater incentive to misstate income in high-priced markets. We report evidence that markets with a tendency for income misstatement also had higher default rates.